1. Field of Invention
This invention relates to valuing option contracts.
2. Background of the Invention
Model Option Contracts
A Model Option contract (also referred to as a “Model Option”) is a new type of option contract that gives the holder the right to settle the contract by selling it back to the option seller at a price determined by a valuation methodology that is specified in the contract. In effect, this is a way of embedding a put option into an option contract since the option holder has the right to put the option contract back to the option seller for a cash value via a settlement right that is specified in the option contract.
Constructing a Model Option contract requires specification in the contract of: basic option terms such as whether it is a put or call, the underlying asset, a strike price, an expiration date or contract term, and the type of exercise that is allowed (American, European, etc.); the additional right to settle the contract by selling it back to the option seller; and a valuation methodology that will be used to determine the value of this additional right.
The additional right to settle the contract by selling it back to the option seller during the life of the contract may be structured in countless ways. A Model Option contract may give the option holder the right to sell the contract back at a preset point or points. It may grant this right continuously over the life of the contract. A Model Option contract may give this additional settlement right continuously over the life of the contract unless certain specified events occur. Alternatively, the contract may give this right only upon the occurrence of certain specified conditions.
In the case of options used as compensation, personal conditions pertaining to the holder might be specified such as age, disability, loss of a loved one, etc. Alternatively, certain corporate conditions might trigger this right or prevent the holder from exercising this right including the possibility of a hostile takeover, the company's bankruptcy filing, or the advent of some other financial event. Other more general conditions that might be used to trigger this additional settlement right or nullify it would include changes in market indicia such as volume of trades, interest rate changes, etc.
The valuation methodology employed in a Model Option must include a description of an option pricing model (such as the Black and Scholes, the binomial, etc.) and how the input values necessary to run the option pricing model will be derived (i.e., the risk-free rate of interest, the volatility of the underlying asset price, the dividend rate, etc.). An information system is necessary to implement the valuation methodology given the complexity of the mathematical calculations employed and the need for accuracy and computational speed.
Model Option contracts can be used in many different ways in conjunction with the market for traditional options or even when there is no market for traditional options on the underlying asset or over a specific time horizon.
Despite the many benefits of using Model Option contracts, users need a method for valuing these contracts that makes sense from a theoretical perspective and is also practical enough to permit real time and continuous usage.